September 11, 2013

Investing, Now vs. Then

An American venture capitalist with two decades worth of experience investing in India recently wrote that for the "start-up ecosystem" to flourish in South Asia, you need six key ingredients:

• Entrepreneurs

• Risk capital

• Inexpensive technology & communication infrastructure

• A talent pool

• Large markets and

• Purposeful government policy

Fair enough, I thought. The list is not unlike what made up the culture of Silicon Valley in the mid- to late-1990s. One element - a talent pool - is especially strong in India because of the young engineers returning home from top-notch universities in America and Western Europe. Plus, they've gotten first-hand exposure to companies such as Google, Facebook, Oracle, and HP both in the West and in India.

Also true, the so-called raw ingredients required for a start-up culture are stronger in an emerging market such as India. In the mid-1990s, Silicon Valley had a lock on the Internet boom. Now, emerging markets like India are taking up the mantle of technology innovation. Today, technology skills are easier to acquire and more dispersed throughout the world's markets.

The globalization of technology has its advantages and drawbacks. To a VC firm looking for potential winners, there's a lot more from which to choose. But investors need to scrutinize the quality of their tech investments to a greater extent than when they plunked down money on anything with a "dot-com" after its name.

In fact, just 20 years ago, more than half of initial public offerings in America were successful. (We define success as when a stock is trading at or above its IPO price 30 days after the offering.) Today just 25 percent of IPOs are successful. Granted, these numbers aren't restricted to just tech companies, but you get the picture. As knowledge becomes dispersed, it's harder to pinpoint winning companies. Add to this scenario the fact that classic marketing problems like crowding still exist.

Yet, Western investors remain cautious when it comes to the emerging markets. Despite the fact that many of them have the elements of a successful start-up ecosystem, investors know that emerging economies and their start-ups often possess their share of volatile characteristics. In fact, the Emerging Markets Private Equity Association (EMPEA) reports that fund-raising in the developing world as of June is half of what it was last year.

When Western economies bounce back, even by a bit, and are inversely correlated to the emerging markets (as they are today), then you'll inevitably see a slowdown in places that nevertheless have the raw ingredients for start-up success. The EMPEA refers to this phenomenon as a movement toward "capital deployment." It's another way of saying that investors generally expect mature markets to show more immediate results.

We know that investing in a company or technology that shows promise also contains an element of chance. So, perhaps, its but inevitable that those markets where an entrepreneurial culture can flourish often provide the most reliable backdrops on which to take a gamble.